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Turning Capital to Wealth: A Ranking of U. S. Utilities

Fortnightly Magazine - December 1999

* (capital employed)]

Thus EVA is a measure of total factor productivity. It not only accounts for O&M items, but all forms of capital (working capital, trade financing, net plant and other assets).

EVA has a separate but equal focus on both operating efficiency and capital efficiency. Over the long-term, increasing EVA leads unambiguously to increasing MVA. In fact, MVA merely is the present value of all future expected EVA. This equivalence is the key to linking a period performance measure (EVA) to a value-creation measure (MVA). Since MVA is based on share price - the market's consensus of future expected value creation - EVA is linked directly to shareholder value creation.

The crucial advantage in using EVA for financial and business management is that it can be operationalized, and linked to all business activities: from strategy and goal setting, to capital budgeting, resource allocation, performance measurement and incentives. A high degree of cohesion results from a single-minded focus on EVA, resulting in large MVA. That sets EVA apart from accounting measures that are hard to link to operational parameters and that ignore the key value determinant: Do earnings exceed the minimum return required by the shareholders? The sidebar, "Beyond Earnings: Why a Value-Added Focus?" examines this question.

Operational Efficiency: A Red Herring?

As mentioned, "The Fortnightly 100," a previous study in this magazine, ranked utilities by their overall efficiency. While several input factors - including book value of plant - were considered, the study focused on operational efficiency. Firms such as Duke, LG&E, Montana Power Co., FP&L, SIGCORP, IPALCO and Black Hills, which fare well in the standardized MVA ranking, also fared well in the earlier study. Large utilities, such as Southern, TXU and PG&E, that did well in the current dollar MVA ranking but not in the standardized MVA ranking, also did well in the earlier ranking.

That suggests that an operationally efficient large utility with inefficient capital use still could have scored well in the previous study. The earlier study noted that the larger utilities had decreasing returns to scale, and alluded to the 40 percent average under-utilization of input factors. This fact is confirmed by our study, where mid-sized utilities outperform the larger utilities in creating standardized MVA.

The earlier study was criticized[Fn.4] for comparing fossil and nuclear utilities, utilities in fuel-producing and non-producing regions and urban and rural utilities. Such criticism misses the point from a shareholder wealth-creation view. Operational excellence is not an end in itself, but a means to create shareholder wealth. While there may be real differences in the operational characteristics of different utility segments, there certainly is a rationale for comparing wealth-creation.

A more recent study[Fn.5] in this journal by some of the authors of "The Fortnightly 100" correlated the market-to-book ratio (M/B) of equity with 12 independent variables, of which productive efficiency was found to be most significant. The M/B ratio is analogous to standardized MVA used in the current study. The results of the two studies thus should produce similar results.

In fact, they do. Standardized EVA has a stronger correlation